The Basics of Trading a Stock: Know Your Orders

With the proliferation of digital technology and the internet, many investors are opting to buy and sell stocks for themselves online instead of paying advisors large commissions to execute trades. However, before you can start buying and selling stocks, it's important to understand the different types of orders and when they are appropriate.

In this article, we'll cover the basic types of stock orders and how they complement your investing style.

KEY TAKEAWAYS

• Depending on your investing style, different types of orders can be used to trade stocks more effectively.
• A market order simply buys (or sells) shares at the prevailing market prices until the order is filled.
• A limit order specifies a certain price at which the order must be filled, although there is no guarantee that some or all of the order will trade if the limit is set too high or low.
• Stop orders, a type of market order, are triggered when a stock moves above or below a certain level; they are often used as a way to insure against larger losses or to lock in profits.

Market Order vs. Limit Order

The two major types of orders that every investor should know are the market order and the limit order.

Market Orders

A market order is the most basic type of trade. It is an order to buy or sell immediately at the current price. Typically, if you are going to buy a stock, then you will pay a price at or near the posted ask. If you are going to sell a stock, you will receive a price at or near the posted bid.

One important thing to remember is that the last traded price is not necessarily the price at which the market order will be executed. In fast-moving and volatile markets, the price at which you actually execute (or fill) the trade can deviate from the last traded price. The price will remain the same only when the bid/ask price is exactly at the last traded price.Market orders are popular among individual investors who want to buy or sell a stock without delay. The advantage of using market orders is that you are guaranteed to get the trade filled; in fact, it will be executed as soon as possible. Although the investor doesn't know the exact price at which the stock will be bought or sold, market orders on stocks that trade over tens of thousands of shares per day will likely be executed close to the bid/ask prices.

Limit Orders

A limit order, sometimes referred to as a pending order, allows investors to buy and sell securities at a certain price in the future. This type of order is used to execute a trade if the price reaches the pre-defined level; the order will not be filled if the price does not reach this level. In effect, a limit order sets the maximum or minimum price at which you are willing to buy or sell.

For example, if you wanted to buy a stock at $10, you could enter a limit order for this amount. This means that you would not pay one cent over $10 for that particular stock. However, it is still possible that you could buy it for less than the $10 per share specified in the order.

There are four types of limit orders:

• Buy Limit: an order to purchase a security at or below a specified price. Limit orders must be placed on the correct side of the market to ensure they will accomplish the task of improving the price. For a buy limit order, this means placing the order at or below the current market bid.
• Sell Limit: an order to sell a security at or above a specified price. To ensure an improved price, the order must be placed at or above the current market ask.
• Buy Stop: an order to buy a security at a price above the current market bid. A stop order to buy becomes active only after a specified price level has been reached (known as the stop level). Buy stop are orders placed above the market and sell stop orders placed below the market (the opposite of buy and sell limit orders, respectively). Once a stop level has been reached, the order will be immediately converted into a market or limit order.
• Sell Stop: an order to sell a security at a price below the current market ask. Like the buy stop, a stop order to sell becomes active only after a specified price level has been reached.

  The Bottom Line

  Knowing the difference between a limit and a market order is fundamental to individual investing. There are times where one or the other will be more appropriate, and the order type is also influenced by your investment approach.

  A long-term investor is more likely to go with a market order because it is cheaper and the investment decision is based on fundamentals that will play out over months and years, so the current market price is less of an issue. A trader, however, is looking to act on a shorter-term trend in the charts and, therefore, is much more conscious of the market price paid; in which case, a limit order to buy in with a stop-loss order to sell is usually the bare minimum for setting up a trade. 

  By knowing what each order does and how each one might affect your trading, you can identify which order suits your investment needs, saves you time, reduces your risk, and, most importantly, saves you money.